We — as a nation, as neighbors and as financial institutions — need to find a workable solution that keeps families in their homes. With 200,000 foreclosure notices going out to homeowners every month, we need to let families know that help is on the way.
The House of Representatives (in a bill called the Housing Retention Act) and the Senate (in a bill called the Foreclosure Prevention Act) are attempting to deal with this problem. These bills have many positive attributes, but they fail the key test. For a family now facing foreclosure, neither of these bills contains strong enough incentives to get people to work things out with their lenders. So lots of families are giving up and moving. As a result, by the time either of these bills is enacted, hundreds of thousands of families already will have sent in their keys and turned off the heat.
Let’s look at these legislative proposals from the point of view of a typical family facing foreclosure. We will call them the "Jones" family. When the Jones family reads the current proposals before Congress, the most exciting provision is in the House bill, which says that as part of the FHA refinancing, their loan will get written down to 90 percent of appraised value, which might be affordable. The Senate bill does not even give this kind of glimmer of hope.
But even if the Housing Retention Bill passes, the Jones family has at least three big questions that these current bills do not adequately address: (1) Since it is voluntary, will their lender be willing to write down their loan? (2) At the time of refinancing, will the interest rate still be 6 percent? (3) Will they meet the criteria and be eligible for this refinancing? And the Jones family must make a decision now.
Creating More Incentives
If Congress, banks, neighbors and the rest of us want the Jones family and hundreds of thousands of others caught up in the subprime mortgage mess to stay in their homes and continue to make at least partial mortgage payments, we need to give them stronger incentives. We need to convince them that if the current legislation passes, it will provide a real and lasting solution to their housing problems. In that regard, the Senate’s "Foreclosure Prevention" Bill sends a strange message to homeowners by including billions of dollars as a tax credit for the people who buy homes, like the Jones’, after the bank forecloses.
My proposal builds on some of the current legislation, including the write-down of mortgages. But that write-down should be compulsory if the homeowners qualify, and not up to the discretion of the lending institutions. We also need to go beyond simply adding an FHA guarantee, by actually subsidizing the mortgage down to a 3 percent interest rate. These measures would keep the Jones’ in their home. They and their lender would have a strong incentive to work out an interim agreement.
Moral Hazard
In proposing a solution to the subprime mortgage mess, most commentators start by assigning blame. If greedy lenders and poor underwriting caused the problem, then the solution is to punish the lenders. If the problem was reckless borrowers, then the solution is to punish the borrowers. The reality is that both the borrowers and the lenders, as a group, did things that were reckless and foolish. They also responded to an unusual housing market, where prices escalated at an unprecedented rate, meaning that most families had no choice but to stretch if they wanted to purchase a home in a decent neighborhood before the prices were completely out of reach.
For their poor judgment and bad decisions, there should be consequences for the lenders. The provision in the Housing Retention Act that requires lenders to write down their loans as part of the FHA-facilitated refinancing seems a reasonable and appropriate consequence. And if homeowners walk away from their homes, the losses will be much worse.
What about the homeowners? Some borrowers may have been talked into taking on mortgages that they did not understand. But at the end of the day, they signed the loan documents. While we would like them to stay in their homes, many people and politicians are reluctant to see them get bailed out. What I propose is that in return for receiving a subsidized loan, these homeowners lose the rights to any future appreciation in the value of their house. When these homeowners sell their house, they would receive a set price that is fixed the day they get their new mortgage.
The legal mechanics of eliminating the opportunity for housing appreciation and what happens when the house has gone up in value is complicated and would require a separate article. But in communities across the country, community development corporations have found ways to cap or eliminate appreciation in housing values, so that the homes they produce remain permanently affordable. Families who live in these permanently affordable homes enjoy the stability of home ownership. The children get to go to nearby public schools. And at some point when the family decides to move out, another family, with limited income, gets the opportunity to live in a house that they can afford.
Out of the current housing crisis, we could create a million units of decent, permanently affordable housing, which could be a step on the ladder as our children move from rental housing to fee-simple home ownership. We could obtain that housing at a great price, as well as make the words "housing retention" and "foreclosure prevention" a reality.
John H. Vogel, Jr. is an adjunct professor at the Tuck School of Business at Dartmouth.
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